Monthly Archives: June 2005

June 30, 2005

Securities Act Reform

At Chairman Donaldson’s last open meeting yesterday, the Commission unanimously adopted rules to reform the Securites Act, substantially as proposed last October. The actual final rules won’t be posted for awhile, but based on comments at the meeting, deviations from the proposed rules appear to include:

Electronic Road Shows – a live road show that is simultaneously transmitted by electronic means to live recipients will still be treated as an oral communication. However, as proposed, a live road show that is recorded and retransmitted on a delayed basis will be treated as a graphic communication, but would be permitted as a free writing prospectus. However, those road show presentations would not be required to be filed as proposed, except in the case of road shows for an initial public offering of equity securities.

Liability – the final rules will provide that prospectus supplements are included in shelf registration statements for disclosure liability purposes, but would establish a new registration statement effective date for Section 11 liability purposes only for issuers and underwriters, but not for directors, officers and named experts, as originally proposed. And cross liability provision will be clarified. One underwriter will generally not be liable for statements made by another unrelated offering participant.

Tweaks on the WKSI Definition – The $700 million public float test for WKSI status will be based on worldwide public float; an issuer will qualify as a “debt-only” WKSI only if it has issued $1 billion or more of non-convertible debt in registered offerings for cash, not exchange. In addition, the final rules provide that a “debt only” WKSI will be permitted to register its equity securities in an automatic shelf registration statement if it otherwise meets the Form S-3 $75 million public equity float requirement.

We are posting law firm memos on the final Securities Act Reform rules here.

Other Open Meeting Items

The Commission voted for a second time yesterday (3-2) to adopt a rule requiring greater independence on mutual fund boards. The Chamber of Commerce is expected to sue the SEC again, accusing it of violating the appeal court’s order. A New York Times article quotes Stephen Bokat, Executive Vice President of the National Chamber Litigation Center as saying “We are going to file a petition to review the SEC’s action today as soon as we can complete the technicalities necessary.”

Additionally, the Commission unanimously voted to approve the shell company rules.

Posted by Julie Hoffman

June 29, 2005

Today at the OK Corral…

First up at today’s SEC Open Meeting is the much anticipated Securities Offering Reform project, where the Commission will consider rules that would significantly revise and update the registration, communications, and offering processes under the Securities Act.

Second on the agenda is the shell company rulemaking project, where the Commission will consider adopting rules amending Forms S-8, 8-K, and 20-F, as well as defining the term “shell company” and amending the definition of the term “succession.”

Third, the Commission will consider issues remanded by the D.C. District Court, in the Chamber of Commerce v. SEC decision. The remanded issues relate to (1) the costs of complying with the 75% independent director condition and the independent chairman condition and (2) disclosure alternatives to the independent chairman condition.

Chairman Donaldson’s decision to schedule the last matter has caused considerable controversy. A USAToday article quoted former SEC Commissioner Joseph Grundfest as saying “The long-run implications of such conduct can only be corrosive and unfortunate” and former Commissioner Bevis Longstreth as saying “Such a course of action could easily be construed as an expression of contempt for the rule of law and the judicial process.”

The gunfight starts at 10 am eastern today and will be available by webcast.

Staff Legal Bulletin 14C Posted

Based on their experience with shareholder proposals in the last proxy season, the Staff issued additional 14a-8 guidance yesterday in the form of SLB 14C. The SLB covers issues that arose commonly in the last season, including:

– the application of Rule 14a-8(i)(6) to proposals calling for director independence;

– the application of Rule 14a-8(i)(7) to proposals referencing environmental or public health issues;

– the application of Rule 14a-8(l); and

– the withdrawal of a proposal submitted by multiple shareholder proponents.

Posted by Julie Hoffman

June 28, 2005

Attention: NYSE-Listed Companies

At last week’s Society of Corporate Secretaries & Governance Professionals conference, Annemarie Tierney of the NYSE’s Office of the General Counsel discussed the director independence determination per NYSE Rule 303A.02.

First, she reminded the audience that the independence determination is a two-part test. Even if a director meets all the bright line criteria set out in Section 303A.02(b), the board is still required under Section 303A.02(a) to make an affirmative determination, based on all relevant facts and circumstances, that the director has no material relationship with the listed company.

Second, she discussed Rule 303A.02’s requirement to identify the independent directors and the basis for such independence determination in the company’s proxy statement. A board is permitted to adopt and disclose categorical standards to assist it in making determinations of independence and may make a general disclosure if a director meets these standards. However, Annemarie said that many companies are not disclosing their independence determination standards or are using the NYSE’s bright line tests as their sole categorical standards. Or, where a director who does not fit within the disclosed standards is determined to be independent, companies are disclosing relationships that exist between the director and the company that are not covered by categorical standards but are not disclosing the basis for its determination that a director is independent despite this relationship.

As a result, the NYSE is looking at all NYSE companies’ most recent proxy statements and will be issuing a comment letter to those companies whose disclosures are deficient. Annemarie indicated that the comments will be in the nature of a “futures” comment from the SEC, and no re-filing of proxies will be required. In addition, companies that receive a comment letter will not need to qualify their NYSE CEO certifications or annual written affirmations. Comment letters are expected as early as this week, and will be running through approximately six months from now.

New Perk Policy at GE

As Mark Borges blogged last week, General Electric has a new policy concerning the personal use of company aircraft by the company’s three Vice-Chairmen. Under the policy, these executives must lease the company’s aircraft for any personal travel once their GE-paid flight expenses for the year exceed $200,000. (GE requires its Chairman and Vice-Chairmen to use corporate aircraft for both business and personal travel for security purposes.)

GE filed a Form 8-K last week detailing the policy. One of the company’s Vice-Chairman has already entered into a time-sharing agreement, where he can lease certain planes from GE for his personal use. A copy of the time-sharing agreement is included in the filing.

-Posted by Julie Hoffman

June 27, 2005

Making Its List…

When the Commission adopted Exchange Act Rule 12g3-2(b) relating to foreign securities, it indicated that from time to time it would publish lists of foreign issuers that have claimed exemptions from the registration provisions of Section 12(g) of the Act. Last week, the SEC published such a list to “make brokers, dealers, and investors aware” that some form of relatively current information concerning the foreign issuers included in this list is available in the SEC’s public files.

Foreign private issuers with total assets in excess of $10 million and a class of equity securities held of record by 500 or more persons, of which 300 or more reside in the United States, are subject to registration under Section 12(g) of the Exchange Act. Rule 12g3-2(b) provides an exemption from registration under Section 12(g) with respect to a foreign private issuer that submits to the SEC, on a current basis, the material required by the rule.

Amended Circular 230 In Effect

In an effort to “improve ethical standards for tax professionals and to curb abusive tax avoidance transactions,” the Treasury Department and the IRS revised their Circular 230, which took effect on June 21. Circular 230 is applicable to attorneys, accountants and other tax professionals who practice before the IRS. The revisions to Circular 230 provide standards of practice for written advice that reflect current best practices and are intended to restore and maintain public confidence in tax professionals. As a result of the new regulations, expect to see tax practitioners including a disclaimer in most written communications (including email!) to clients to the effect that any tax advice provided in such communication may not be relied on by a taxpayer to avoid penalties.

See law firm memos on this topic here.

Most Recent Monthly Columns on

Steve Glover has posted his monthly column on on the how’s and why’s of spin-offs and related transactions. This month’s submission covers split-up transactions.

Gary Lawrence’s monthly column on covers the practical aspects of conducting due diligence for business transactions. This month, he addresses due diligence and Section 11 issues.

-Posted by Julie Hoffman

June 24, 2005

Pfizer’s Novel Approach to Majority Voting

This morning at the Society’s National Conference, Peggy Foran discussed how Pfizer just announced how their company amended their corporate governance guidelines so that any director who receives a majority withheld vote is required to tender their resignation. The company’s board can then choose whether to accept the tender – which allows for the board’s judgement to be exercised.

This is akin to the similar provision that exists in many corporate governance guidelines regarding change in job responsibility for a director. When I get back from vacation, in a podcast, Peggy will explain why they did it, the issues involved in the form of a written tender, etc.

Letter from Council of Institutional Investors on Majority Voting

This query was recently posted in the “Q&A Forum”: “We received a letter from CII asking us to adopt a policy regarding majority voting for directors. According to CII’s web site, they sent the letter to 1,500 of the largest US companies. I am interested in how others who received this letter plan to respond.”

Here was my response: “Just listened to a discussion on this at the Society’s National Conference – must folks seem to be taking a “wait n’ see” approach to what others do (and then likely will respond with a letter that says their board is closely studying the issue as there a lot of groups currently deliberating the issues and presenting their findings in the near future).” Note that the CII’s letter notes that any responses will be posted on their website!

June 23, 2005

Mark it Down – ’33 Act Reform on June 29th

As soon as I blogged yesterday that the rumor about the SEC adopting ’33 Act reform on June 29th might no longer hold water, the SEC announced that the Commission indeed will consider adopting the reform on the 29th. Besides ’33 Act reform, the Commission will consider its outstanding shell company proposal – as well as the cost-benefit analysis and alternatives of the already adopted mutual fund board independence rules (as required by the DC Circuit Court decision that I discussed in yesterday’s blog). Look for sparks to fly on this last agenda item at the open Commission meeting!

Do you know what else happens on June 29th? As reported Tuesday in the WSJ, 60% of the companies listed on the Toyoko Stock Exchange hold their annual stockholders meetings! Talk about bad governance – this practice ensures that investors are not able to attend many of these meetings.

ABA Discussion Paper on Majority Voting

The ABA Committee of Corporate Laws has issued a 32-page discussion paper on majority voting – and now seeks reactions to its objective analysis, as noted on the last page of the paper. A copy of this paper is posted in our “Majority Vote Movement” Practice Area.

Ten Reasons Why You Should Hear What Fred Cook Said!

Fred Cook truly gave a seminal speech – “Fred Cook Speaks to Directors” – on Tuesday during which he imparted wisdom from his 40 years serving as a compensation consultant. Here are 10 Good Reasons why all your directors, staff and advisors should hear what was said during this critical event (the text and video archive now are available on

1. Fred starts off in “The Cycle of Executive Compensation” by explaining how we got here – which is important to understand in order to reverse course. Fred notes “Executive compensation is not “out of control” as some alarmist critics hold. The start point is totally under the control of the compensation committee….”

2. Fred explains how surveys are a major cause of the escalation of CEO pay in “The Problem with Surveys,” by providing a series of candid observations, such as “Why are we so dependent on surveys to set the start point of executive compensation? The answer is that we do not know how to value the job of management.” Fred’s pointers are set forth in an important supplemental two-page paper for directors on the use – and misuse – of surveys.

3. In “How Did Stock Options Come to Dominate Executive Compensation?,” Fred explains the important concept of “equity carried interest” – which is essential for boards and advisors to understand. Fred also provides ten reasons why option and equity grants have grown to such high levels that may not be in a company’s best interests.

4. Noting that many boards are looking for equity alternatives in the face of option expensing, in “A Warning About Restricted Stock,” Fred explains why using survey values to convert options into other grant forms on a dollar-for-dollar basis is a fundamental mistake

5. Perhaps Fred’s most practical and innovative guidance comes during “What’s Another Approach to Equity Grant Guidelines?” as he provides a framework for determining how much equity is appropriate to motivate executives to provide value.

6. This framework is further explained in a supplemental paper, “A Different Approach to Stock Option Grants – Stock Option/Pay Multiple Formula.” Fresh thinking that is a must for all compensation committees!

7. In “Internal Pay Equity,” we expect that Fred’s story about implementing internal pay equity methodology at a leading company should encourage many more of us to ask our HR heads or consultants to implement this important alternative to external peer benchmarking.

8. Fred outlines six common traps during “What Are Some Traps Compensation Committees Should Avoid?”

9. In “What Are Evolving Best Practices in Executive Compensation Governance?,” Fred delves into six practices that are emerging as best practices today.

10. In addition to this seminal speech, much more of Fred’s wisdom – as well as practice pointers from our 75 Task Force members – are available on today. And our “2nd Annual Executive Compensation Conference” – live in Chicago or by video webcast – will feature important practical guidance from luminaries like Fred, John Reed and other notable directors and expert advisors.

June 22, 2005

More on Failure to File 10-K as a Credit Default

Following up on last week’s blog regarding not filing a 10-K as a credit default, Tom White of Wilmer Cutler Pickering Hale & Dorr notes that Saks is not the first company to deal with this issue. In fact, Tom points out that bondholders might not necessarily agree that this is merely a “technical” default, as Professor Coffee implies. Without current reported financial information, it becomes more difficult for holders to trade the bonds.

The countervailing consideration is that sending the notice can itself cause a downgrade, sell-off or other bad repercussions (that assumes this is “bad” from the bondholders’ perspective – some bondholders might view a sell-off as an opportunity to acquire more bonds) .

Starting the 60-day clock gives the bondholders leverage (note how Saks is now offering to buy back $1.2 billion of its debt in exchange for waiver of the requirement to timely file its 10-K). Besides putting pressure on the company to get the reports done, it enables the bondholders to bargain for consent fees and other concessions (e.g. public disclosure of certain selected current operating and balance sheet data) in exchange for a waiver in case the company can’t file the 10-K within 60 days (which typically is the cure period provided for in the indenture before repayment is accelerated).

Whether bondholders would play it out and actually threaten to accelerate would be an interesting question. If they thought the company had the financial capacity to refinance the bonds, it might be a gambit to get them paid at par. The collateral consequences, however, are so dire that it is likely that bondholders would be hesitant to pull the trigger absent a payment default.

One interesting legal issue is whether receipt of the notice of default is an 8-K Item 2.04 or Item 8.01 disclosure. Tom believes it’s an 8.01 disclosure.

SEC (Partially) Rebuked Over Fund Board Independence

Yesterday, a three-judge panel of the U.S. Court of Appeals for the D.C. Circuit ordered the SEC to reconsider recently adopted rules requiring mutual funds to be overseen by independent chairmen and that fund boards be comprised of 75% independent directors. Today, about 80% of fund companies, including the two biggies (Fidelity and Vanguard), have boards run by insiders. Here is the 19-page court opinion in Chamber of Commerce of the United States of America v. U.S. Securities and Exchange Commission.

The Chamber of Commerce had argued that the Investment Company Act of 1940 didn’t provide authority for the SEC to regulate “corporate governance” and, in any event, that the SEC had adopted the rules without adhering to the requirements of the almighty Administrative Procedure Act.

The Court held that the SEC didn’t exceed its statutory authority in adopting the rules and that the SEC’s rationales for the rules satisfied the APA. The Court, however, also found that the SEC did violate the APA by failing adequately to consider the costs mutual funds would incur to comply with the rules – and by
failing to adequately consider proposed alternatives (such as mandatory disclosure by funds regarding the level of independence of their board), the Court remanded the rulemaking to the SEC so it can address the deficiencies identifed in the opinion.

It’s a little unclear if the Commission will need to take another vote on the fund rules once the cost-benefit analysis is complete, alternatives are considered and public comments are received (my guess is “yes”). The discussion of “Consideration of Alternatives” on pages 17-19 is particularly significant. In fact, the entire opinion is worth reading.

It will be interesting to see if any last-minute rule adoptions come out of the SEC before Chairman Donaldson’s departure on June 30th. Now, we might not see the ’33 Act reform calendared on June 29th – as Reuters reported a few weeks back – because this court decision understandably might lead the Chairman to be gun shy (Note: a few hours after I originally posted this, the SEC announced a meeting on the 29th). Isn’t it remarkable that Commissioners Glassman and Atkins will get “another bite at the apple” on fund board independence – they were vehemently opposed to the new rules – without incoming Chairman Chris Cox having to intervene? Of course, we don’t know Mr. Cox’s views on these fund issues yet.

M&A Bootcamp – Delaware Law Considerations

On, you can now listen to Delaware law experts John Grossbauer and Mark Morton of Potter Anderson during their 45-minute session on Delaware Law Considerations. These guys do a great job covering the waterfront in such a short period of time. It’s not too late to take in the Bootcamp – with reduced membership rates for the “Rest of 2005” now available – only $100 for a single user license!

I’m (Nearly) Going to Disneyland!

I’m heading to Los Angeles tomorrow for the Society of Corporate Secretaries annual conference – always an informative and fun event. I’m excited to serve on the Society Board’s Executive Committee during the last year of my term in office; also did so during my first year on the Board. I love working with such knowledgeable and dedicated colleagues.

Then off on vacation next week as we drive up the California coast. Giant Forest, hear we come! I will blog remotely for a few days and then Julie Hoffman will be blogging for your pleasure next week. Have a great 4th!

June 21, 2005

The SEC’s Latest Take on Qualitative Materiality

A few weeks back, the SEC settled a civil enforcement action alleging that Huntington Bancshares (and its CEO, former CFO and former controller) engaged in financial reporting fraud in connection with the company’s 2001 and 2002 financial statements. The complaint also alleges failure to maintain accurate books and records and adequate internal controls, and the filing of materially false CEO and CFO certifications.

As noted in this Sullivan & Cromwell memo (posted in’s “Hot Topics Box” on the home page), the following points are of particular interest from this action:

– In assessing the materiality of the alleged accounting improprieties, the SEC focused on qualitative materiality factors. In particular, the SEC stressed that, while the increases in reported operating earnings resulting from the improper accounting methods may have been quantitatively fairly small (3% in 2001 and 5% in 2002), they were material because they enabled Huntington to meet or exceed Wall Street analysts’ earnings per share estimates and to meet internal EPS targets that determined management bonuses.

– The alleged improper accounting occurred despite Huntington and its management team having a due diligence and disclosure process in place, involving meetings at which senior management discussed the accounting treatment with, among others, external auditors and legal advisors. The SEC alleged that, in some cases, the defendants acknowledged in these meetings that the accounting was improper, but concluded it need not be changed because the errors were not material.

– In several cases, the alleged improper accounting was a continuation of accounting practices that were established years earlier – before the individual defendants were at the company – and were approved by outside auditors at the time of establishment and on an ongoing basis.

The bottom line is that qualitative materiality analyses are alive and well at the SEC. This case is a reminder that even very small percentage amounts can still be material under the circumstances.

Bona Fide CEO Succession & Selection Processes

With CEO succession in the news, there is much food for thought in this lengthy interview with Mark Van Clieaf on Bona Fide CEO Succession & Selection Processes. Mark is a key session leader for an upcoming August 8th symposium about the 5 Levels of Corporate Governance and related director strategic duties and liabilities to be held in Toronto.

Task Force Report on Private Placement Broker-Dealers

During last week’s meeting of the SEC Advisory Committee on Smaller Public Companies, some members noted a reference to an ABA Task Force Report on Finders that was recently published. This 71-page Report on private placement broker-dealers is quite interesting and comprehensive – and covers a wide range of issues, from M&A to litigation. It is posted under “Alerts” on the home page and in “Hot Topics Box.”

June 20, 2005

Egads! The Big Three?

Lots of news about KPMG pleading for its life due to the tax shelters it sold in the 1990s and its subsequent alleged obstruction of justice activities (see these court opinions that illustrate how aggressive KPMG was in the lawsuits filed against them over the tax shelters, much to the judiciary’s chagrin, and last week’s apology from KPMG for this aggressive posture). In my mind, it’s pretty clear that the corporate world cannot live with only three major audit firms, as the independence rules often forces companies to hire at least two – if not three – of the Big 4 to perform the various audit and non-audit services they need.

In this blog, a venture capitalist notes how he testified last Friday before the SEC’s Small Business Advisory Committee that “the formation of a fifth or sixth major national auditing firm would provide small companies with a better alternative that what exists today while helping to restore the balance of negotiation between auditing firms and their clients.”

Of course, creating additional national audit firms is no easy feat. To see how far the auditing profession would have to change to create them, read this recent article that indicates that the 5th largest firm presently has no Fortune 500 clients – and only two of the Fortune 500 companies use an auditor other than the Big 4.

The problem with relying on smaller audit firms to conduct public company audits is reflected in a recent Glass Lewis study. The June 2nd study reveals that smaller audit firms have an error rate of about three times that of the larger audit firms – and small public companies have a much higher restatement rate than that of large companies. Overall, the restatement (i.e. error) rate in financial statements audited by smaller audit firms is high – and thus commands a higher price for capital. So I believe we are just plain stuck with the Big 4 for the time being.

So the question remains: how does the market (or regulators) ensure that these “too big to fail” entities don’t cross the criminal line? One thought is for audit firms to have a board of directors, with independent directors to oversee management and ensure that the appropriate culture and behavior is instilled. The use of an oversight body should help protect audit firms from these “death penalty” type of situations – and ultimately protect investors as well as clients.

Probably a crazy notion if you thought of this governance framework in the law firm context. But one crucial difference between a law firm and an audit firm: a lawyer’s role is to serve as an advocate for clients; an auditor’s role is more about getting clients to conform with applicable regulations. Let me know your reactions to this dilemma.

Fred Cook Speaks from Stanford Directors’ College

Hopefully, each of you will be able to watch to Fred Cook’s groundbreaking video webcast tomorrow on “Fred Cook Speaks to Directors.” Fred’s speech should have a major impact and keep our momentum going in the area of responsible compensation – and we urge that all directors should view this video live or by archive.

I have seen a draft of Fred’s presentation (we call Fred the “Dean” of compensation consultants) – and you will not be disappointed as it contains some fresh thinking. Plus, this video event enables you to get a taste of what it is like to attend Stanford Directors’ College, which is quite pricey to attend live since it caters to directors.

Managing D&O Departures and Arrivals

We have posted the transcript from the webcast, “Managing D&O Departures and Arrivals.” This was one of my favorites, as I tend to like the governance stuff the most.

SEC Commissioner Goldschmid to Hang Around

Urged by Democratic Senators, who reportedly are scared what Commissioners Atkins and Glassman would do if he left without a replacement, Commissioner Goldschmid (a Democratic appointee) has agreed to stay at the SEC, at least through the end of the summer. Goldschmid’s tenure arrangements at Columbia University requires that he rejoin the faculty soon.

Some Senators are trying to get the Bush Administration to name a replacement for Goldschmid – as well as re-up Commissioner Campos, the other Democratic appointee whose term expires soon – as part of a package deal with Chris Cox’s Chair confirmation. No word yet as to what President Bush intends to do.

June 17, 2005

Zero Tolerance for Tandy Language Modifications

A number of members have asked whether they are permitted to modify the Tandy Letter language in their responses to comments from the SEC Staff. As you might recall, the Staff began requiring Tandy Letter language in all response letters last August, as part of the project to post all comment and response letters on the SEC’s website. The required language is an acknowledgement that “the company may not assert staff comments as a defense in any proceeding initiated by the Commission or any persons under the federal securities laws of the United States.”

Objections to broadly requiring this acknowledgement have been made by the ABA Committee on Federal Regulation of Securities and two committees of the New York City Bar Association. Desired tweaks include such matters as being able to assert the SEC effectiveness order as a defense in an action alleging unregistered sales of securities or the absence of scienter. Another issue is what does the phrase “as a defense” mean, exactly? Would it prohibit using a staff comment ‘to explain’ why certain things were done?

Before last August, the SEC Staff only required this language when the Staff had an open Enforcement inquiry related to a particular company – but this selective approach became unworkable when response letters became universally available.

The SEC Staff’s position continues to be that the Tandy Letter language must be included in the initial response letter and that none of the Tandy Letter language can may be modified – similar to the Staff’s “no changes allowed” position on Section 302 certifications – and the Staff will not tolerate any changes whatsoever. I touched a little more on this topic during yesterday’s webcast” “How to Navigate Tricky Confidential Treatment Requests.”

Delayed 10-K as Credit Default

Yesterday, the NY Times ran this article about how a hedge fund has sent Saks a notice of default on some convertible notes due to a delayed 10-K. In the article, Professor Coffee comments on how novel and aggressive this is as its a “highly technical default”, not an economic one (i.e. about whether the company can pay on its convertible debt) – and he also notes how it might not be just the best strategy, but perhaps the start of a trend.

1K! Broke My Maiden!

After two and a half years in this job, we just crossed the magic “1000” (aka “one large”) mark for questions posted in the Q&A Forum, available from the top tool bar on our home page (can’t link directly to the Forum because oddly the URL changes each time a new question or answer is posted).

Quite a body of knowledge has built up there – and the pace of questions has really picked up this year. Scared to see size of the thing 10 years from now. The Q&A Forum is intended to be an interactive community forum, so feel free to reply any time to a question – and you can also reply to a reply if ya want. [fyi – “broke my maiden” is a horse racing term used to describe when a horse wins its first race.]